Lenders Face GSEs' Multifamily Shift

After several years of putting most of the multifamily mortgages they bought in their portfolios, Fannie Mae and Freddie Mac are preparing to rev up securitization of such loans.

For lenders that do business with the government-sponsored enterprises, this shift in funding strategy will affect the types of mortgages that can be offered to apartment landlords. Securitization requires more standardized loan structures, forcing borrowers to give up customized terms, though in exchange they can get lower rates than those available from portfolio lenders.

"Some of the more sophisticated clients … had negotiated pretty customized loan documents with Fannie and Freddie over time," said Todd Goulet, a senior vice president with the real estate capital group at Cleveland's KeyCorp.

"A lot of what they're used to getting in the portfolio execution, they're not going to get in the securitization execution," he said. "So from our perspective, it's getting those borrowers to get comfortable with the more standardized documentation."

The GSEs cited different motivations for their respective efforts.

Fannie said it is retooling for an eventual future in which the GSEs would be forced to slash their massive portfolios of mortgage assets — even though the government right now is enlisting the companies to take on ever bigger roles in housing policy.

"We don't want to be dependent solely on Fannie Mae's retained portfolio as our funding source," said Phil Weber, Fannie's senior vice president for multifamily. Fannie once relied heavily on mortgage-backed securities to fund its multifamily business. Mr. Weber said returning to that model "is our top priority" in the multifamily business this year.

It will take a few quarters before Fannie achieves its goal of guaranteeing at least $500 million of multifamily bond issues a month and serving "the market mainly through MBS issuance."

The change entails canvassing a group of investors that Fannie and its lender partners have not called on since the GSE shifted to portfolio financing a few years ago.

Freddie, on the other hand, never did much securitization of multifamily loans. The GSE says it began planning several years ago to develop third-party funding outlets but got sidelined, and is now moving forward with the idea.

Michael May, Freddie's senior vice president for multifamily, said that in 2006 the GSE looked at ways it could compete with Wall Street conduit lenders, then at their height.

Investment banks were offering highly competitive rates to owners of apartment buildings; the loans were pooled with ones secured by office, retail, industrial and hotel properties, then profitably resold into the bond market.

Freddie "decided that having more options on how we finance makes a lot more sense and makes us competitive through all market cycles," Mr. May said. But "at that time, the market was super-hot and frankly, nobody really wanted to talk to us all that much about our programs because there was so much liquidity." (Fannie shifted to portfolio financing around the same time because of competition from the conduits.)

Since then the securitization markets have seized.

Last year Freddie began buying multifamily loans with the intention of packaging them into a large bond offering. Mr. May said the GSE expects to have a pool of sufficient size to issue the bonds next quarter.

Notably, Freddie wants to use a structure that was typical of Wall Street in its heyday but is unusual for a GSE.

Rather than guaranteeing all the bonds, Freddie would create senior and subordinated securities, and try to sell off the latter, riskier pieces. It would either buy the senior class or guarantee it and sell those bonds to other investors.

Mr. May said the success of such an offering would depend on investors' faith in the company's track record of low delinquencies. But "we believe we've got real interest. … There's real capital available."

Freddie will play it by ear, Mr. May said.

"If and when the first one goes and it's successful, we'll aggressively pursue the next deal."

If the market rejects the offering, Freddie will turn to the simpler, more common structure of pass-through securities with its guarantee.

Ultimately, Mr. May said, the GSE hopes to "have three options" for multifamily loans — held in its portfolio and financed with Freddie's debt; the Wall Street-style securitizations; and pass-throughs.

"There's times when debt will be the [cheapest] and there's times when securitization will be the [cheapest] for the borrower," he said. "I want to see a material amount of my mortgage purchases … financed with some form of securitization. … The more you do, the more people understand, the less fear there is, the more liquidity that's generated, and the better the pricing. It's a virtuous cycle."

As of Sept. 30, Fannie owned or guaranteed close to $170 billion of multifamily mortgages. Freddie owned $68 billion and guaranteed about $15 billion of such loans.

William Hyman, the senior managing director for agency lending products in the commercial real estate group at Centerline Capital Group, said the New York company is "seeing significant appetite for Fannie Mae MBS paper from investors."

Most of the lender's current Fannie business involves lining up investors to buy a Fannie-guaranteed security backed by a single multifamily loan that Centerline originated.

Even if the terms are less flexible for the borrower than in loans headed for a portfolio, the price is better.

"We're seeing a lot of interest at levels that are significantly better than where Fannie Mae would buy the paper" for its portfolio, Mr. Hyman said. "We can give a Fannie Mae borrower the best rate by offering them a simple 10-year fixed-rate loan with a" prepayment penalty.

Richard Parkus, the head of commercial mortgage-backed securities research at Deutsche Bank AG, said that if this market is to rebound, securities that are "secured by agency-quality multifamily loans" and guaranteed by Fannie or Freddie would likely lead the way.

"The underwriting standards really never slipped on the agency multifamily loans in the same way that they did on other commercial mortgages," he said.

About 2.6% of the multifamily loans in commercial mortgage securitizations were delinquent by 60 or more days as of last month, Mr. Parkus said.

Fannie's 60-day multifamily delinquency rate increased 4 basis points from October and 17 basis points from a year earlier, to 0.25% in November. In December the 90-day multifamily delinquency rate at Freddie was 0.01%, flat compared with November and 1 basis point lower than a year earlier.

"Will delinquency rates go up? For sure," Mr. Parkus said. "But they're going to go up because it's a tougher economic environment, not because of weak underwriting. This is an area that's not a disaster waiting to happen."

Mr. Goulet said today's multifamily guidelines are "a heck of a lot better underwriting than what you were seeing in the 2006 conduit market."

The GSEs have retrenched to products with loan-to-value ratios of 70% to 80% and debt service coverage of 125%, he said.

"They've eliminated some of the more aggressive products that they had," such as financing for buildings that were not yet fully leased or where cash-flow projections were based on anticipated increases in rent following a renovation.

Mr. Hyman said "the jury is still out" for Freddie's Wall Street-style bond deal.

"It's too soon to tell how that will be received, because they haven't gone to the market yet." However, he said Centerline would consider buying the subordinate piece of the offering.

Under an "interim final rule" issued by the Federal Housing Finance Agency, the GSEs' regulator and conservator, last month, Fannie and Freddie would be allowed to increase their portfolios (which include single-family and multifamily holdings) to $850 billion each by the end of this year, then have to reduce them 10% a year beginning in 2010 until they reach a new maximum of $250 billion. A Treasury Department financial support arrangement established when the GSEs were seized in September capped their debt at 110% of the amount outstanding at June 30. At the end of last year, Fannie's retained portfolio totaled $805 billion and Freddie's $787 billion.

Under the housing plan unveiled by the Obama administration last week, the portfolio caps are to be raised to $900 billion and the debt limitations are to be eased in tandem. Fannie said Monday that "the increase in the portfolio cap does not change the [multifamily] business' strategy for moving to" securitization.

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